Banks are Greece’s Achilles’ heel

The country probably won’t be forced out of the euro. But there is a scenario where this could happen. This involves Syriza, the radical-left party, winning the upcoming election and then running out of time before it can perform the policy U-turn necessary to keep its creditors on side. Depositors might then panic.

Syriza is the clear favourite in the Jan. 25 election. If it emerges victorious, it could be headed for a clash with its euro zone creditors. The party has promised to cut Greece’s debt and increase public spending, but it won’t be able to get an agreement to do this.

Germany, which drives euro zone policy, is not too afraid of financial contagion if Greece defaults on its debts and quits the euro. Berlin is more worried about the political contagion if it cuts Athens too much slack. Other countries, especially France and Italy, might then go slow on implementing their own economic reforms.

This is not to say that Greece does not deserve some form of extra debt relief if it keeps up its reform efforts. Encouragingly, Syriza has promised much-needed crackdowns on tax evasion and oligarchs. The snag is that it will be politically almost impossible for its creditors to cut the headline debt level.

The obvious compromise, the rough parameters of which have already been discussed between the current government and the euro zone, is to fix the interest rate at extremely low levels and extend the grace period before any of the loan has to be repaid.

Could Syriza accept such an approach to the debt? Could it also agree to refrain from a spending splurge?

Possibly, given enough time. But there is no doubt that it would involve a somersault, or what the Greeks call “kolotoumba.” Many of its activists would view this as a betrayal of everything they stand for.

What’s more, Syriza thinks it can play hardball. A common theory is that, because Greece now has a budget surplus before counting interest payments, Athens could default unilaterally on its debt and keep the show on the road.

Doing so would be a dangerous folly. While the government could indeed fund itself if it refused to pay its debt, a default could provoke panic among bank depositors. In such a scenario, the ECB would no longer provide liquidity to Greek banks – making a bank run rational.

Indeed, the central bank fired a warning shot last week saying effectively that it would no longer act as a lender of last resort to the country’s banks after the end of February unless Athens secured an extension of its current bailout programme, which runs out then.

Greece’s own central bank may still be able to supply what is known as “emergency liquidity assistance” if needed. But the ECB would probably veto this too if a new government wasn’t at least seriously negotiating an extension of the programme.

If there was a bank run without a safety net, the government’s only option would be to impose capital controls. Unless it then appealed to its creditors for mercy, it would have to bring back the drachma.

What’s more, Athens’ own finances are stretched because it hasn’t agreed to the latest demands of its creditors and so hasn’t received the last dollop of bailout cash. Unless it can scrape together cash from somewhere, it will run out of money by the end of February.

All this means that if Syriza wins the upcoming election, it will immediately be under extreme time pressure. Its first priority, to form a government, won’t be easy because it is unlikely to have an overall majority. Syriza would have to secure a coalition and its most obvious partner, the centrist To Potami movement, is adamant that it won’t agree to a deal that could put Greece’s membership of the euro at risk.

To Potami should stick to its hard line. This would mean insisting that Syriza ask nicely for an extension of the bailout plan. To get this, it would have to agree in broad terms to the programme that it has spent years denouncing. This would require a rapid kolotoumba from Syriza’s leader, Alexis Tsipras. That’s why it is quite possible that there will be no coalition deal and a second election will be called for late February or early March.

By that stage, the heat would really be on. The end-February cutoff of ECB support would either have passed or already be looming. Deposit flight could also have taken off. Remember, a bank run started between the two elections of 2012.

If there is a second election this time, the principal job of the caretaker government that would run the country in the intervening period should be to ask for at least a short extension of the programme until a proper government was formed.

But the top priority now is for the euro zone creditors and the moderate elements in Syriza to put out feelers to one another to work out how the party could perform a kolotoumba without too much of a loss of face. The creditors should indicate that they will extend the bailout deal so long as Syriza asks for one nicely. After all, it is in nobody’s interest for Greece to be driven out of the euro.